Sometimes politicians don't know how powerful they are. The UK Labour leader Ed Miliband, for instance, seems able to cause the London Stock Exchange to plummet just by speaking. First he promised price caps on energy companies, and their shares reeled. Then last week he promised to break up the banks, whereupon billions were wiped off their value.

As Jeremy Warner tellingly observes in Saturday's Daily Telegraph, Miliband is not the first in his party to want to get tough on bankers. When Gordon Brown became Chancellor in 1997, he instructed the OFT's John Bridgeman to investigate their supposed lack of competitiveness. Bridgeman refused on the grounds that he could find no sign of anti-competitive behaviour. So Brown set up his own inquiry under former telecoms regulator Don Cruickshank. As intended, he reported that the banks must be uncompetitive because they were making so much money on their capital. But "It didn't seem to occur to Cruickshank that the more plausible explanation for high returns was that the banks were operating on dangerously small levels of capital," writes Warner.

Anyway, by the time Cruickshank reported, the banks were making so much money, and contributing so much in tax to the Exchequer, that Brown no longer wanted to break them up. Indeed, he went the other way, suspending competition rules to allow Lloyds buying the near-insolvent HBOS, a "final act of folly" which taxpayers got the bill for.

There is indeed far too little competition in UK banking. America has 7,000 banks. In Britain, four banks control about 4/5 of the banking market, and five control 2/3 of the mortgage market. That is because of too much regulation, not too little. Regulation is a fixed cost. Big firms can bear it, small ones cannot. That is why the newcomer MetroBank is the first high-street bank to be created since Georgian times.

Miliband's prescription is typically statist. He wants to break up the big banks and "create two 'challenger' banks." Why two? Why not six, eight or fifteen? How does a politician – or anyone else – know how many banks (or energy companies, or carmakers, or supermarkets, or dog groomers and cafes, for that matter) we should have?

Obviously, the best thing is to leave such decisions to the market. But at present, the market is rigged, through regulation, in favour of big firms. It is right that there should be strong capital controls on large banks: if RBS or Lloyds skate on dangerously thin capital, they could bring down the entire financial system. If some tiny bank goes down, that is unfortunate, but not catastrophic, and we can deal with it just as we deal with any other small business failure.

So the solution seems obvious: have stringent enough capital regulation on large banks, and less stringent rules on small ones. That would encourage newcomers and innovators to enter the markets – not just two "challenger" banks but potentially dozens, even hundreds. And it would encourage the larger banks to break themselves up. Which they would probably do in a way that made much more business sense than any break-up engineered by clod-hopping officials employed by Business Secretary Vince Cable or would-be Prime Minister Ed Miliband.